Tax and financial strategies for real estate investors

Real estate investors run up against some unique tax issues and have business models different from the everyday entreprenuer. Below are ten areas where we often find room for improvement, tax savings or just a better understanding of one's real estate investing activities.

1. Know where the money goes. Setup a system so that the funds you invest are separate from personal or other business funds. This is imperative for a lot of reasons, not the least of which is that smart investors know their financial position at all times. You should also be able to separate your basis in the property from your ongoing expenses. This last point holds true for individual home owners as well.

2. Consider your liability exposure. LLC’s have become very popular with real estate investors. However, a corporate charter may be invalidated if you are not treating it as a bona fide corporation. In some cases a good general liability insurance policy will do you more good.

3. Get educated on Section 1031 exchanges. In today’s real estate market almost everyone has heard of these, but few people know the details. You cannot afford to be wrong when considering a 1031. Conversely, you cannot afford to miss the opportunity to make one work.

4. Know how to take advantage of your gains and losses. Property held for more than a year can usually be treated as long-term gain subject to 15% tax rates. In a market where large gains have been the norm it can be worth your while to study other investment holdings with your tax advisor to determine if stock or other capital losses can be used to offset some of your gains. Property held for less than one year is taxed at your marginal tax rate which could be as high as 35%.

5. Beware of self employment tax. If your investment activities rise to that of a real estate professional you could be subject to an additional 15.3% tax and all of your gains could be treated as ordinary income subject to marginal tax rates. An S corporation can mitigate this but once you turn your investing activities into a business you need to be aware of the increased tax rate.

6. Build an after-tax budget. How many businesses do you know that routinely ignore 15-30% of their operating costs. Taxes are the greatest expense for most real estate investors. Have your tax advisor determine the after-tax ROI for every opportunity you are considering. The differences can be dramatic.

7. Consider designating a second/vacation home. Property taxes and interest expense that might otherwise be disallowed deductions could work to your benefit depending on how much rental activity you have on a property. Boats and RV’s can also qualify for this designation.

8. Beware of FIRPTA. The Foreign Investment Real Property Tax Act requires you to send 10% of the sales proceeds to IRS when selling to a foreign non-resident. If you fail to do this then you (not your title company or realtor) will be held liable by the IRS. Reputable real estate agents are well aware of the pitfalls in this area, but if you are handling your own deals make sure you have this base covered at all times.

9. Convert a rental property to a personal residence. This option can allow you to pull out substantial capital gains tax free upon the eventual sale of the property. It can even work in cases where the property has been the subject of a 1031 exchange.

10. Use your IRA. There is a growing trend of using self-directed IRA’s to purchase real estate investments. IRS has a plethora of rules and regulations that must be followed for this to work but it can yield significant returns on your investment if done right.

These are just a few of the strategies and ideas available to real estate investors. It has been our experience that the investors themselves often come up with some of the more creative and insightful strategies. Every real estate deal has its own set of facts, some which have not been anticipated by the current crop of tax strategists. In these situations it is important to have someone who can bounce around your ideas and formulate solutions unique to your investment.